In economics and finance, Value at Risk (VaR) for a financial portfolio is a measure of the portfolio's maximum loss not exceeded with a given probability, defined as the confidence level, over a given period of time. VaR is commonly used by financial institutions to measure the market risk of their asset portfolios. VaR may be thought of in the following form: “We are X percent certain that we will not lose more than V dollars in the next N days,” where V is the VaR of the portfolio (expressed in dollars in this example), N is the time horizon, and X is the confidence level. In practice, time horizons (N) of one (1), five (5), ten (10), and twenty (20) days are used, and confidence levels of 99% or 95% are used. Thus, in general, when N days is the time horizon and X % is the confidence level, VaR is the loss corresponding to the (100-X)th percentile of the probability distribution of the change in the value of the portfolio over the next N days.
There are many known ways to compute VaR, including historical simulation and Monte Carlo simulation. Most VaR-calculation methodologies, however, do not explicitly model the different liquidities of the of the market risks involved. As a result, the prior art tends to overweight liquid factors for VaR time horizons greater than one day. Thus, methodologies for determining VaR that are more objective and that appropriately consider the liquidity of market risks are needed.